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Rh Operation of the System.—The operation of the Federal Reserve System may be divided into three distinct periods, the first from Nov. 2 1914 to the declaration of war by the United States April 6 1917; the second extending from the latter date to a period some time after the conclusion of the Armistice of Nov. 11 1918 (the date most aptly chosen for the close of this period probably being Nov. 4 1919); while the third period extended from the latter date to the close of the year 1920. During the first or pre-war period the functions of the system were concerned largely with the organization of its own constituent units and the modification of banking practice in the United States and with the establishment of methods suited to the initiation of the new plan. These functions naturally fell into two main groups: (1) in the internal organization of the Federal Reserve banks, and (2) in the establishment of satisfactory relationships between them and their members. In the latter category should be placed the work done in perfecting coöperation between the banks and the clearing houses of the different communities and in developing methods of collection, in working out plans for rediscounting with the least possible delay and friction, and other matters of equal importance. In the same group of functions must also be placed the work done by the Federal Reserve System in developing a new standard for commercial paper. The Federal Reserve Act had given to the Federal Reserve Board the duty of defining commercial paper. Consequently, one of the first undertakings of the board was the establishment of regulations designed to cover the different classes of commercial paper and the processes to be pursued by reserve banks in discounting such paper. These regulations did not have the force of law since they merely amounted to a statement of the standards with which commercial paper must comply in order to be “eligible,” that is to say, to be rediscountable at the Federa b l e Reserve banks. Nevertheless, the growing power of the Federal Reserve banks was such that these standards of eligibility rapidly came to be recognized through the whole of the banking community. Progress was made in the matter of securing nearly identical methods of preparing financial statements to be used for the purpose of testing the credit position of firms who were presenting paper for discount. An outstanding element in the work of the Federal Reserve Board during this first period was the national and district clearance and collection system. The Federal Reserve Act had authorized the board to act as a clearing house for the several reserve banks, and early in 1915 the board took action by establishing the so-called Gold Settlement Fund at Washington. Each bank contributed originally a sum of $1,000,000 in gold, the entire amount being stored in the Treasury or the sub-treasuries. Claims accumulated by reserve banks upon one another were each week telegraphed as an aggregate to the board at Washington and offset against one another, the net debit or credit balances in the fund being registered in a set of books created for that purpose. The size of the fund grew rapidly and eventually reached a maximum of about $500,000,000. A second section of the fund was established to provide for clearances growing out of the accounts of Federal Reserve Agents as distinct from the bank to which they were accredited. The Gold Settlement Fund probably would not have been successful alone had it not been supported by some plan for the collection of items originating within the several districts. Such a plan was, however, worked out and put into effect in practically final form beginning about July 1 1916. This was the so-called “intradistrict” collection system. It provided for the depositing of cheques (at first only on member banks but finally on any other bank or any banker) by members or holders of clearing accounts with Federal Reserve banks. These cheques were sent to the banks upon which they were drawn, the latter being required to remit the proceeds in cash or acceptable exchange or to authorize the charging off of these remittances upon the books of the reserve banks. Member banks, of course, habitually followed the latter plan, while non-members who had no account with the reserve bank were obliged to furnish exchange or send coin. Although there was opposition from the banks which had previously made a profit out of this kind of exchange business, the opposition

gradually lessened. Possibly the most vigorous form which it assumed was seen in the amendment to the Federal Reserve Act adopted in 1917, in which exchange charges made by member banks were recognized but which, on the other hand, practically neutralized such charges by providing that the Federal Reserve banks should not be permitted to pay exchange. The matter was promptly tested in the courts, and as a result of favourable decisions and of the evidently beneficial character of the system, the number of banks which agreed to clear at par was extended until in 1920 it included more than 29,000 institutions—practically all the banks of the United States. The total operations of the Federal Reserve intradistrict clearing system were at the rate of $13,124,000,000 per month during the year 1920.

War Finance.—Although the Federal Reserve System had practically established itself during the two and a half years of its existence prior to the entry of the United States into the war in April 1917, it was doubtful whether the resources of the system were sufficiently large to enable it to bear the strain which all recognized would be thrown upon it as soon as war demands began to make themselves felt. Accordingly Congress, upon recommendation of the Federal Reserve Board in June 1917, passed an amendatory Act which provided that nothing should be counted as reserve except balances on the books of Federal Reserve banks. The United States had declared war on April 6 1917, and almost immediately thereafter many of the larger State banks and trust companies, which had previously hesitated to become members, filed their applications, actuated partly by patriotic desire to strengthen the Government's accounts and partly by the fact that the severe financial stress of the war would be most easily met by the institutions which had joined the system. This movement into the Federal Reserve System was accelerated through the amendatory Act to which reference has already been made, so that in the course of the year 1917 the resources of the System were enormously increased, while its gold holdings were vastly added to through the gradual withdrawal of coin not only from the vaults of banks but also from circulation. Shortly after the declaration of war the Secretary of the Treasury had placed an issue of $50,000,000 of treasury certificates of indebtedness with the reserve banks, but it was promptly recognized that this plan of financing was unsound; and subsequent issues, both of long-term bonds and of Treasury certificates, were placed with member banks and so far as possible with the public through the reserve banks acting as intermediaries. It was seen from the outset, however, that in order to keep the rate of interest on Government bonds at a low figure and to insure wide distribution of the bonds, it would be necessary to guarantee their holders that they could borrow freely by using them as security at rates which would involve no expense. Consequently, from the date of the First Liberty Loan (June 1917) onward, banks all over the country undertook to loan to their customers on Liberty Bonds such amounts as the customers might need, running up to a total close to the face of the bonds, and at the same time reserve banks undertook to rediscount the notes collateraled with these bonds when received from the member banks. As the Government itself had entered, upon a wide scale, into business enterprises growing out of the war, a large and increasing volume of its payments for supplies, services and other needs was made out of the proceeds of bonds and certificates and this class of paper accordingly superseded in a corresponding degree paper which would otherwise have been made by business men for the purpose of financing their ordinary transactions. Both in order therefore to assist the rank and file of the public in absorbing Liberty Bonds and to facilitate the Government's own operations, there were large additions to the portfolios or holdings of reserve banks and the amount of the notes they issued and the deposits they entered on their books increased rapidly. At the end of 1917 there was outstanding in notes $1,247,000,000 while reserve de- posits were $1,446,773,000 and total resources were $3,089,945,000. These conditions were more and more accentuated as the war continued, particularly in view of the fact that the U.S. Government found it necessary to advance large sums to foreign countries, selling Liberty Bonds in order to provide the means for so doing. The consequence was an enormous increase of general prices brought about partly by the steady draft upon the consumable commodities in the country which were exported in great quantities (the total shipments during 1918 being $6,149,087,545 as against $2,484,018,292 in 1913), while they were partly due also to the great increase of bank-notes and bank deposits both on the books of members and of the reserve institutions themselves. It had been hoped that upon the declaration of the Armistice there would be a reaction to more conservative methods of financing, but the enormous commitments which had been made in sending about two million soldiers to France and in taking from the Allied Governments their obligations to a total eventually of about $9,600,000,000, constituted a situation which could not be immediately altered. In fact, war expenses continued to increase for several months after the Armistice, and the floating of a Fifth, or Victory, Loan, early in 1919, was essential in order to fund some part of the immense floating indebtedness of